“Enhanced” Index Funds?
Posted by texasmoose on May 25, 2007
Over at Fidelity, where I have my IRA and Roth accounts, I received an e-mail touting their new “enhanced” index funds. Hmmmm, “enhanced.” I understand the concept of an index fund, which is managed to track a particular benchmark or index. The benefit of an index fund is that management is minimized; all the fund manager has to do is follow the index. This has the benefit of reducing fund expenses, and the majority of index funds often outperform actively managed funds. However, the fund’s return is often slightly below the return of the index, due to the expenses.
So, what’s up with this “enhanced” index fund? Fidelity says:
The funds’ managers use computer models to sift through the universe of stocks and rank them based on predicted performance. The results are then optimized to construct a portfolio that is comprised of the highest ranking stocks, but resembles the benchmark index in terms of sector/industry weights and other risk-related factors. What you are left with is a fund that seeks to out-perform the index while matching the risk, yield and other characteristics of a comparable index fund.
Uh…isn’t that an actively managed fund? Am I missing something? Sure they use the index as a foundation, but then they apply subjective criteria to the stocks that comprise the index. The criteria may be based on objective factors, but choosing which criteria to apply and their application itself is subjective. Fidelity says that their range of return is greater when compared to the index. For example, a standard index fund, according to Fidelity, will return between -0.2% to -1.2% when compared to the index benchmark, while the enhanced index fund will return between +3.2% to -1.5%. Fidelity does acknowledge that the enhanced fund has more risk than a plain vanilla index fund, but that the expected excess return more than offsets the risk. I guess the expectation is that the return of the enhanced fund will generally beat the index due to the active management “enhanced indexing.”
I’m a fan of indexing, but will wait and see how these funds perform. In any case, like most other Fidelity index funds, the minimum investment is $10,000, and I don’t have that much in my IRA and Roth accounts yet, so I cant invest anyway. But that doesn’t mean I won’t keep my eyes on them…
